Unbelievable collapse in small-cap stocks

Michael A. Gayed, CFA, winner of the 2014 Dow Award, is chief investment strategist and co-portfolio
manager at
Pension Partners, LLC., an
investment advisor which manages mutual funds and separate accounts according
to its ATAC (Accelerated Time and Capital) strategies focused on inflation
rotation. Prior to this role,
Gayed served as a portfolio manager for a large international investment group,
trading long/short investment ideas in an effort to capture excess returns. From
2004 to 2008, Gayed was a strategist at AmeriCap Advisers LLC, a registered
investment advisory firm that managed equity portfolios for large institutional
clients. In 2007, he launched his own long/short hedge fund,
using various trading strategies focused on taking advantage of stock market
anomalies. Follow him on Twitter @pensionpartners and YouTube
youtube.com/pensionpartners.

"It's unbelievable how much you don't know about the game you've been playing all your life." — Mickey Mantle

Small-caps tend to get lot of attention by traders/investors because of their tendency to outperform bigger companies over large markets cycles. Many of these companies tend to trade with less dollar volume compared with large-cap equities, are highly sensitive to domestic growth expectations, and can be seen as a good indicator of risk sentiment beneath the surface.

On the latter point, I know everyone remains mesmerized by the Standard & Poor’s 500 Index
SPX, -0.23%
but the reality is that many stocks in the U.S. have been struggling in 2014, with market cap being a key decider of just how tough it's been. The small-cap Russell 2000 Index
RUT, +0.54%
meaningfully underperformed the S&P 500 this year in a shocking way, causing them to give back all of their 2013 outperformance, and sending it's price ratio relative to large-caps all the way down to 2011 levels.

Approximately 24% of the Russell 2000 is made up of Financials, which we are underweight in our equity sector ATAC Beta Rotation Fund
BROTX, +0.58%
Take a look below at the price ratio of Russell 2000 ETF
IWM, +0.55%
relative to the S&P 500 SPDR ETF
SPY, -0.15%
As a reminder, a rising price ratio means the numerator/IWM is outperforming (up more/down less) the denominator/SPY. A falling ratio means underperformance.

That is utterly brutal, and came out of nowhere. This implies two things which are important to keep in mind. First, we remain in an unprecedented environment. For small-caps to be collapsing this hard and suddenly is unusual when considering where the Federal Reserve thinks the domestic economy is headed. Second, if most money is hiding out in the S&P 500, then we are seeing a narrowing of attention by traders.

On that point, it is often said that the narrower a rally gets, the closer it is to nearing its end. While this will only be known with hindsight, it is worth nothing that "staircase up/elevator down" dynamics haven't disappeared. The relative collapse is a humble reminder that advances can be given back in a moment's notice when you least expect it, regardless of asset class, strategy, or cap.

And it may not be over just yet.

This writing is for informational purposes only and doesn't constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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